Capital has always been regarded as the lifeblood of business, and it remains one of the most important arbiters of success in the international hospitality industry. As massive amounts of capital circulate in the financial markets, the New Economy is triggering explosive transformations, from industry convergence to world-changing technology advances. Accessing capital, particularly among traditional industries like hospitality that rely heavily on physical assets, has become more complex and competitive than ever before. The fourth global study in the Hospitality 2000 series, as a result, focuses on capital—the financial resources required for hotel property development and acquisition, as well as for creating and expanding hospitality enterprises. Our investigation necessarily spanned two arenas: the property markets and financing available for the operational side of the business. In both areas, the complex nature of hospitality organizations has tended to create hurdles for accessing capital. Many companies in the hospitality industry play a dual role as both real estate owners and as managers of operating businesses. For those with interests in the hospitality sector, the general lack of appreciation for the complexities of the operational side of the business remains a source of considerable frustration. Our questionnaire polled senior executives in the Americas, Europe, the Middle East, India, Africa, and Asia/Pacific. The focus—current and future trends in hospitality capital sources, market structures, investment and lending preferences, approaches to underwriting, investment metrics, property market trends, international investment, and lender attitudes. The spotlight was also cast on how the industry is financing one of its most important value creators, technology. This year’s survey was again cosponsored by Arthur Andersen with New York University’s Center for Hospitality, Tourism, and Travel Administration and HFTP. In this report, we summarize highlights of the wide-ranging findings in this year’s Hospitality 2000 study. New Economy sets the stage. The hospitality industry’s capital needs must be set against a backdrop of fast-paced change, today often described as part of the New Economy. The New Economy is being driven by four key trends—globalization, the revolution in communications, consolidation in industry, and technology. Indeed, technology-driven change has created a vast, networked economy with the world’s financial markets at the cutting edge of globalization. Hospitality companies that seek capital from the public marketplace will, at a minimum, need to understand the market’s changing dynamics and be able, where necessary, to function as global enterprises. Within the New Economy there is also a growing appreciation of the value of intangible assets such as information, brands, customers, relationships, and networks. Driving a migration of value towards intangible assets is of course the Internet and its role in allowing businesses the world over to web-enable many key processes. And while most hospitality enterprises are only just beginning to face up to this reality and what it means for their basic processes, over the long-term we can expect the Internet, and digital communications in general, to play an increasing role in the way hospitality capital markets evolve and mature. Where does the industry access capital? Much has been written about strategy and organization in the international hospitality industry, with considerably less attention paid to how the industry sources and uses its capital. Hospitality 2000: The Capital fills that gap. To gain breadth and depth in our study, we surveyed three separate groups—the providers of capital; intermediaries, such as international property brokerage firms and investment banks; and the users of capital, including developers and hotel companies. Private financing for both property and enterprises has historically dominated the international hospitality industry. The trend toward securitization of real estate in countries like the United States can be seen as the initial steps taken toward more efficient use of the public capital markets. Not surprisingly, however, our respondents rank private investment and venture capital funds as the most significant source of equity capital on the property front today on a global basis, followed by capital invested by hotel companies, both public and private. Predictably, commercial banks take the lead on providing property-level financing around the globe, and respondents see no change in that role in the future.
Technology investments demand increasing capital. As our previous survey, Hospitality 2000: The Technology, indicated, we can safely predict that there will be significant demands for capital to cover technology investments in the years ahead. The choices that hospitality companies make in the technology realm will have a significant impact on competitiveness and on return to investors.
In our current study, Hospitality 2000: The Capital, our respondents report different processes for making those investments. Forty percent of senior executives have some responsibility for investing in technology, but the approach varies. Fifty-seven percent of these executives report that their companies have a formal annual IT budgeting process involving the senior management team. Fourteen percent indicate these processes involve just one or two key executives. An additional 14 percent indicate their organizations use an informal approach involving the senior management team as the need arises. Finally, 11 percent also have an informal approach, but involving just one or two key executives. Clearly with the deployment of capital into IT set to increase in the years to come, some hospitality companies may wish to adopt a more formal approach to the process of IT investment decision making.
Once capital is invested in IT, it is frequently forgotten as suggested by the 61 percent of respondents who report having no formal measurement system in place to monitor IT investment performance. This is somewhat akin to investing in hotel property and then never receiving or reviewing the property’s financial statements. But respondents appear to recognize the problem—63 percent report plans for such a system to be deployed over the next three years. Our respondents also ranked the metrics used in evaluating investments in IT. These measures include cost reduction (77 percent), employee productivity (73 percent), revenue enhancement (64 percent), return on investment or ROI (50 percent), payback period (41 percent), and internal rate of return (32 percent). Our respondents indicate that revenue enhancement and ROI measures will be used more in the future, while others are projected to decline moderately. As part of the capital budgeting process for IT, there are two key costs that are not always accounted for—implementation costs and on-going support costs. We asked respondents about these, finding that 90 percent of respondents include the first of these in their IT budgeting but only 76 percent include the latter. The financing of IT spending through leasing rather than purchasing accounts for a portion of total IT spending in the industry—but not much. On the basis of the weighted responses received by respondents, we estimate that approximately 15 percent of total IT spending is financed this way, and it is marginally more popular in the Americas (16 percent) than in EMEIA and Asia/Pacific (13 percent in each region). Vendors of IT also provide financing to their customers in the hospitality industry, but again it is not a significant portion of total IT spending—just 13 percent overall. Some IT applications can, however, be paid for on a "price per use basis," although it too is not prevalent—only 14 percent of respondents overall indicated they had any applications paid for in this way. Finally, the outsourcing of non-core functions in business at large has become a popular strategy. One-third of respondents indicate that a portion of their IT is currently outsourced. And an additional 38 percent are either currently considering or would consider an outsourcing of part or all of the function.
Industry consolidates, but respondents question M&A results.
In the future, large hospitality enterprises are projected to benefit most from consolidation, while small businesses can be expected to be negatively affected as capital providers look for scale, branding, technology, and global presence in the businesses they finance. Only 49 percent of respondents believe that the results projected of a merger will actually be delivered currently, although in the future they believe this may improve—but only marginally. This reflects a reality facing hospitality managers as they consider mergers and acquisitions in the future. In a significant number of cases, the combination of two organizations does not always produce the intended benefits of the merger or acquisition. Investor attitudes—majority are positive. Investor attitudes to hotel property are currently more positive (52 percent) than negative (44 percent), while in the future, the positives are expected to increase to 66 percent. On the enterprise side, the negatives for investors are currently marginally higher than that for property (47 percent versus 44 percent), while in the future, this is expected to worsen (50 percent versus 23 percent). Evidently, investors have a better feeling for the prospect of investing in hotel property than in hospitality enterprises. Both investors and lenders to hospitality enterprises exhibit a current preference for international hotel chains and this is likely to continue in the future across all regions. And both groups also have a strong preference for property acquisition, as opposed to new property development, which they tend to view somewhat negatively.
On an overall basis, our respondents rank property in an order close to their quality ratings with the exception of the top position which is drawn by "four-star/upper mid-scale" property, followed by "five-star/luxury" and then in sequence, three-, two-, and one-star/budget property sequentially. It is also noteworthy that by and large, lenders indicate a marginal preference for four-star versus five-star products in all three regions.
Underwriting standards vary, but location ranked as the key factor. Underwriting terms, of course, vary considerably in the business cycle with these standards relaxed during times of rapid expansion and capital availability. Regardless of these fluctuations, the age-old adage of location, location, location appears to ring true for respondents across the board. Location is consistently ranked as the number one factor affecting investment and lending decisions. In ranking the various measurements used to evaluate property investments, respondents overall rate the internal rate of return as the most important. Cash on cash returns using stabilized earnings follow with payback periods and per room costs relative to comparables sharing third and fourth rankings. Lenders have these same rankings. In terms of the assumptions used for debt in underwriting, the mean average debt-to-total capitalization ratio is 61 percent overall for a standard three- to four-star commercial hotel in the respondent’s local market.
Debt service coverage ratios average 1.5 times in the Americas, but a significantly more conservative ratio of 2.1 times in EMEIA and 2.4 times in Asia/Pacific, these differences partially attributable to the different degrees of leverage assumed in each region.
For a forecast period, underwriters select from six to 11 years. Residual capitalization rates used to capitalize the last year’s earnings of a projection to arrive at residual value range from 9 to 11 percent. The discount rate used to discount a future stream of "free and clear" hotel property income (before interest, taxes, depreciation, and amortization) back to the present, along with the net residual value to arrive at a present valuation, ranges from 10 to 13 percent.
Where can investors find the best property returns? Our research queried respondents by region on hotel property returns, and the responses varied significantly. EMEIA respondents indicate they believe that satisfactory hotel property returns can be found today in the United Kingdom, France, the United States, Scandinavia, the Middle East, Canada, South America, and Italy. And in the future EMEIA respondents include Southeast Asia. Executives in Asia/Pacific believe that satisfactory returns may be found in the United States, the United Kingdom, France, and Scandinavia, but not in Asia/Pacific itself. But in the future—apparently believing the industry is on the upswing—they add Southeast Asia and South America. Finally, respondents from the Americas believe that satisfactory returns can be found in the United States, Canada, France, and the United Kingdom currently, and for the future, they add Southeast Asia and Germany. For investors in hotel property, expectations for rate of return on invested capital change inversely by property classification—the higher the quality of the property, the lower the return. At the luxury five-star level, overall returns are expected at about 14 percent, increasing 100 basis points at the four- and three-star levels, to 15 and 16 percent respectively, and then 200 basis points to about 18 percent at the one- and two-star levels. Debt financing varies by property or enterprise. Lenders make distinctions between opportunities to lend against hotel property and those associated with loans to hospitality enterprises involved in management and marketing. Twenty-three percent of our respondents report providing debt financing to the industry. Of these, 88 percent offer financing for hotel property, while considerably less—42 percent—provide financing for hospitality enterprises. For borrowers seeking debt capital for hotel property acquisition or development, the question of security is of paramount importance. In the United States, the concept of "non-recourse" mortgage financing represents the vast majority of hotel property lending reported by Americas’ respondents (79 percent). By sharp contrast, only 2 percent of property lending in Asia/Pacific is reported as non-recourse, while 76 percent is guaranteed by the borrower. The balance (22 percent) is a combination of the two. In EMEIA, the distribution is more even with 44 percent of property lending reported as non-recourse, 40 percent guaranteed, and the balance (16 percent) a combination of the two.
Of all respondents, 42 percent project an increase in the availability of attractive lending opportunities, this ranging from 50 to 51 percent of respondents in Asia/Pacific and EMEIA respectively to 36 percent of respondents in the Americas. By contrast, 31 percent of all respondents indicated they saw no change in the future, while a minority (23 percent) projected a decline. In tracking the performance of hotel property lending, we inquired about default rates on hotel property loans. On an overall basis, 11 percent of respondents cite the rate as either significant (8 percent) or very significant (3 percent), while one in four claim it is moderate. Conclusion Hospitality 2000: The Capital offers a diverse view of capital sources and use across the international hotel industry. By and large, that profile is positive as capital providers indicate a willingness to finance the industry, albeit with relatively strong underwriting standards. Hospitality management in the future, however, will need to compete head-to-head against other investment opportunities, some of which are highly appealing in terms of risk-adjusted returns, in the global financial markets. Accessing capital will not only be a key challenge for management in the future, but a driver of industry transformation as hospitality organizations embrace new ways of doing business and serving the customer in the years ahead. Hospitality 2000: The Capital Hospitality 2000: The Capital is the fourth in a series of global studies being completed under the Hospitality 2000 initiative, which was undertaken to define critical issues that the industry will face in the next millennium. Our first report, Hospitality 2000: A View to the Next Millennium, identified major trends and strategic issues focused around market, product, organization, technology, and capital. Hospitality 2000: The People addressed organization and strategy, recruitment and staffing, training and development, performance, reward, and recognition. The third in the series, Hospitality 2000: The Technology, addressed strategy, organization, sales and marketing, customer information, and operations as they relate to technology and its future role in the industry. This year’s research study, Hospitality 2000: The Capital, addresses the long-term trends of significance in the sourcing and use of capital in the international hospitality industry. The Sponsors The cosponsors of this year’s study were Arthur Andersen LLP, New York University’s Center for Hospitality, Tourism, and Travel Administration, and the international association Hospitality Financial and Technology Professionals (HFTP). The Methodology Following the proven research methodology used in previous Hospitality 2000 studies, the research was conducted by completing a broad-ranging review of the literature, and preparing, testing, and mailing a detailed questionnaire covering a variety of issues raised in the sourcing and use of capital. The targeted audience for the survey included providers of capital such as investors, lenders, and financial institutions, users of capital such as private and public hotel companies and hotel property developers, and finally intermediaries for capital such as brokers and investment banks. Major regions surveyed included: the Americas, Europe, the Middle East, India, Africa, and Asia/Pacific. The findings and conclusions are based on 180 returns. The Report In addition to a comprehensive report on the data, findings and conclusions from the survey research, Hospitality 2000: The Capital showcases a number of organizations that are involved in the sourcing or use of capital for the hospitality industry. These case studies can be regarded as illustrative of how the industry and the hotel property it operates are currently being financed, as well as future trends. To Order Hospitality 2000: The Capital Please call toll free to 800-872-2454 (US) or 1-941-373-2020 (outside US). Orders can also be taken by fax at 1-941-341-4312. Or contact us via e-mail. The Hospitality 2000 reports are available at the following prices:
Roger S. Cline, a partner of Arthur Andersen LLP, is director, Hospitality Consulting Services. He has directed the Hospitality 2000 research initiatives in concert with the cosponsors during the last four years. Mark Warner, DPA, CHE, is director for graduate programs, Center for Hospitality, Tourism, and Travel Administration, New York University. With Arthur Andersen, he has coordinated the Hospitality 2000: The Technology and The Capital research projects. |
